Monetary Federalism: The Case of the CIS
bdesilets
0 views
20 slides
Sep 27, 2025
Slide 1 of 20
1
2
3
4
5
6
7
8
9
10
11
12
13
14
15
16
17
18
19
20
About This Presentation
This paper, Monetary Federalism: The Case of the CIS (Desilets, 2003/2004), explores how theories of optimal currency areas, fiscal federalism, and economic growth can be applied to explain the persistence of “local” currencies within larger monetary systems. It examines the dissolution of the r...
Slide Content
1
MONETARY FEDERALISM
The Case Study of the Commonwealth of Independent States
1
Brien Desilets
University of Barcelona
May 2003, Revised October 2004
JEL Code: E50
ABSTRACT:
The paper reviews literature from optimal currency area, fiscal federalism and economic growth
theories to provide some guidelines for optimal monetary policy and to develop an explanation
for “local” currencies, or currencies that exist within larger currency areas. An empirical study
measures the efficiency of a currency area for the Commonwealth of Independent States and
provides a specific focus on Armenia in which both joining the CIS in currency union and
dollarizing are found to be sub-optimal.
1
The author is extremely grateful to Dr. Nuria Bosch, University of Barcelona (UB), for her intellectual and administrative
support and guidance throughout the preparation of this report. Drs. Albert Sole, Eduard Berengeur, Carles Sudria and Joachin
Ferran, also from UB, provided very helpful comments and suggestions. The work benefited greatly from the author’s
conversations with Tigran Poghosyan of the Central Bank of Armenia and Dr. James McHugh, Resident Representative to
Armenia for the International Monetary Fund (IMF).
MONETARY FEDERALISM
The Case Study of the Commonwealth of Independent States
1
Brien Desilets
University of Barcelona
May 2003, Revised October 2004
JEL Code: E50
ABSTRACT:
The paper reviews literature from optimal currency area, fiscal federalism and economic growth
theories to provide some guidelines for optimal monetary policy and to develop an explanation
for “local” currencies, or currencies that exist within larger currency areas. An empirical study
measures the efficiency of a currency area for the Commonwealth of Independent States and
provides a specific focus on Armenia in which both joining the CIS in currency union and
dollarizing are found to be sub-optimal.
1
The author is extremely grateful to Dr. Nuria Bosch, University of Barcelona (UB), for her intellectual and administrative
support and guidance throughout the preparation of this report. Drs. Albert Sole, Eduard Berengeur, Carles Sudria and Joachin
Ferran, also from UB, provided very helpful comments and suggestions. The work benefited greatly from the author’s
conversations with Tigran Poghosyan of the Central Bank of Armenia and Dr. James McHugh, Resident Representative to
Armenia for the International Monetary Fund (IMF).
Local Currencies: Theories and Evidence
2
I. INTRODUCTION
Economic theories and empirical studies have yet to solve the question of currencies. While the countries
of Europe have formed one of the world’s largest ever currency unions and developing countries have
effectively expanded the U. S. currency union by dollarizing—whether through policy or practice—other
currency unions have disintegrated, most notably the ruble zone comprised of the former Soviet Union.
To complicate matters, some local authorities have issued their own currencies while remaining within
larger currency unions. These include Argentina’s provinces, which issued local currencies worth more
than US$4.3 billion in response to the nation’s economic and financial crisis in 2001
2
. They also include
several countries that extensively use “vehicle” currencies, such as the euro or the dollar, but continue to
maintain their own national currencies.
What purpose do these “local” currencies that exist in a world of large currency unions serve? Why is
reliance on one of the world’s major currencies insufficient for economic and financial activities? Are
local currencies simply conduits for financial corruption at the local level, or do they serve some specific
purposes in local economies? When should a country (or local authority) join a currency union and when
should it issue its own currency? Should governments choose between currencies or should they facilitate
the use of more than one currency within their jurisdictions?
At least three divisions of economic theory offer explanations for the use of local currencies. The theory
of optimal currency areas identifies parameters that determine the best geographic domain for a currency,
based on variables such as factor mobility, the value of non-tradables, the quality of monetary
management, economic diversification, liquidity and alignment with fiscal systems. Fiscal federalism
theory determines the efficient level of government for various functions, including stabilization and
monetary policy. Economic growth theory predicts the income effects of changes in interest rates, effects
of geographically related externalities and economic integration.
In general, it may be said that local currencies allow for more appropriate monetary policy that satisfies
local preferences, thereby facilitating local economic activity. Local currencies make it possible to pay
the costs of supply and demand shocks through exchange rate changes rather than adjustments in price
levels or employment. Local currencies also provide the issuer with seignorage. On the other hand,
increasing the number of currencies used in an economy increases transactions costs, including
uncertainty about the future exchange rate. The costs and benefits of local currencies are summarized in
Table I.
The following three sections review the literature of optimal currency areas, fiscal federalism and
economic growth theories in an attempt to identify the most useful explanations of currency use. Section
V examines a few models and studies that do not fit neatly into any one of these three divisions. Section
VI draws some observations from the literature. Section VII provides an empirical application of a model
that is most closely associated with the fields of Optimal Currency Areas and Fiscal Federalism to the
case of the Commonwealth of Independent States. Section VIII examines the specific case of Armenia,
which is interesting because it is part of the former ruble zone and now maintains its own, free-floating
currency. It also is a de facto part of the dollar zone, given that the vast majority of its bank deposits are
in dollars. In addition, Armenia is a relatively small currency zone (it has fewer than 4 million people by
most estimates), so if it is determined efficient, it may help to define the parameters at the other end of the
spectrum from studies that have sought to explain or justify the euro and dollar zones. Section IX
concludes the paper.
2
Standard and Poor´s 28 February 2002.
2
I. INTRODUCTION
Economic theories and empirical studies have yet to solve the question of currencies. While the countries
of Europe have formed one of the world’s largest ever currency unions and developing countries have
effectively expanded the U. S. currency union by dollarizing—whether through policy or practice—other
currency unions have disintegrated, most notably the ruble zone comprised of the former Soviet Union.
To complicate matters, some local authorities have issued their own currencies while remaining within
larger currency unions. These include Argentina’s provinces, which issued local currencies worth more
than US$4.3 billion in response to the nation’s economic and financial crisis in 2001
2
. They also include
several countries that extensively use “vehicle” currencies, such as the euro or the dollar, but continue to
maintain their own national currencies.
What purpose do these “local” currencies that exist in a world of large currency unions serve? Why is
reliance on one of the world’s major currencies insufficient for economic and financial activities? Are
local currencies simply conduits for financial corruption at the local level, or do they serve some specific
purposes in local economies? When should a country (or local authority) join a currency union and when
should it issue its own currency? Should governments choose between currencies or should they facilitate
the use of more than one currency within their jurisdictions?
At least three divisions of economic theory offer explanations for the use of local currencies. The theory
of optimal currency areas identifies parameters that determine the best geographic domain for a currency,
based on variables such as factor mobility, the value of non-tradables, the quality of monetary
management, economic diversification, liquidity and alignment with fiscal systems. Fiscal federalism
theory determines the efficient level of government for various functions, including stabilization and
monetary policy. Economic growth theory predicts the income effects of changes in interest rates, effects
of geographically related externalities and economic integration.
In general, it may be said that local currencies allow for more appropriate monetary policy that satisfies
local preferences, thereby facilitating local economic activity. Local currencies make it possible to pay
the costs of supply and demand shocks through exchange rate changes rather than adjustments in price
levels or employment. Local currencies also provide the issuer with seignorage. On the other hand,
increasing the number of currencies used in an economy increases transactions costs, including
uncertainty about the future exchange rate. The costs and benefits of local currencies are summarized in
Table I.
The following three sections review the literature of optimal currency areas, fiscal federalism and
economic growth theories in an attempt to identify the most useful explanations of currency use. Section
V examines a few models and studies that do not fit neatly into any one of these three divisions. Section
VI draws some observations from the literature. Section VII provides an empirical application of a model
that is most closely associated with the fields of Optimal Currency Areas and Fiscal Federalism to the
case of the Commonwealth of Independent States. Section VIII examines the specific case of Armenia,
which is interesting because it is part of the former ruble zone and now maintains its own, free-floating
currency. It also is a de facto part of the dollar zone, given that the vast majority of its bank deposits are
in dollars. In addition, Armenia is a relatively small currency zone (it has fewer than 4 million people by
most estimates), so if it is determined efficient, it may help to define the parameters at the other end of the
spectrum from studies that have sought to explain or justify the euro and dollar zones. Section IX
concludes the paper.
2
Standard and Poor´s 28 February 2002.
Local Currencies: Theories and Evidence
3
II. OPTIMAL CURRENCY AREA THEORY
Three articles form the base of optimal currency area theory, those by Mundell, McKinnon and Kenen.
Mundell [1961] defines a currency area as a region within which exchange rates are fixed and an optimal
currency area as one in which factors of production are mobile and without which factors are immobile.
In his two-area model, an area that faces increased demand permits its currency to appreciate. If it does
not, it faces inflation and the other area in the model faces increased unemployment. If the two areas
share a single currency or fix their exchange rates, economic shocks would be transmitted to both.
McKinnon [1963] stresses the importance of the non-tradable sector and notes that a separate currency is
more efficient for an area that has a large non-tradable sector, with the exchange rate fixed to a
representative basket of non-tradable goods and services. As the size of the tradable sector increases, so
do the arguments in favor of a fixed exchange rate, or currency union.
McKinnon also notes that the liquidity value of money decreases with the size of its area of use and with
bad monetary management, giving incentives to savers to demand more of another currency. Because of
this, he concludes that small countries with weak currencies will finance the balance of payments deficits
of large countries with more liquid currencies, even when investment returns are higher in the small
countries.
McKinnon’s article concludes with a special note on factor mobility. He recognizes the importance of
geographic factor mobility as described by Mundell, but also stresses the importance of industrial factor
mobility. He explains that factors do not need to migrate between geographic areas if they can migrate
between industries in the same area.
Kenen’s [1969] principal argument is that the economic diversification of an area may be more important
than factor mobility in determining optimal currency areas. He explains that a diversified economy will
be less affected by terms of trade shocks. Its resilience to such shocks increases with the extent of its
import-competitive industries and the industrial mobility of its production factors. He does not discuss
the effects of monetary unions on diversification, thereby implying that there are no limits to the size of a
diversified monetary area.
Kenen also notes the need for a liquid currency with a stable value to serve as the standard for allocating
capital among regions. He suggests that the currency of the largest region or the region with the best
monetary management would be converted to the inter-regional standard.
A. The Related Topic of Capital Markets
Ingram [1959] analyzes the balance of payments between North Carolina and other States in the U. S. He
finds that the availability of a large stock of tradable capital, i.e. federal government bonds, solves
transfer problems and other balance of payments pressures and could be more important than a single
currency in facilitating balance of payments adjustments. He notes that the establishment of the Federal
Reserve System coincided with the increased use of general government bonds by commercial banks (see
Table II). Ingram concludes that the development of an integrated capital market, mostly in the form of a
large stock of tradable capital units, eliminated regional payment pressures previously experienced in the
U. S. The existence of non-tradable capital units separates economic systems and produces balance of
payment pressures.
3
II. OPTIMAL CURRENCY AREA THEORY
Three articles form the base of optimal currency area theory, those by Mundell, McKinnon and Kenen.
Mundell [1961] defines a currency area as a region within which exchange rates are fixed and an optimal
currency area as one in which factors of production are mobile and without which factors are immobile.
In his two-area model, an area that faces increased demand permits its currency to appreciate. If it does
not, it faces inflation and the other area in the model faces increased unemployment. If the two areas
share a single currency or fix their exchange rates, economic shocks would be transmitted to both.
McKinnon [1963] stresses the importance of the non-tradable sector and notes that a separate currency is
more efficient for an area that has a large non-tradable sector, with the exchange rate fixed to a
representative basket of non-tradable goods and services. As the size of the tradable sector increases, so
do the arguments in favor of a fixed exchange rate, or currency union.
McKinnon also notes that the liquidity value of money decreases with the size of its area of use and with
bad monetary management, giving incentives to savers to demand more of another currency. Because of
this, he concludes that small countries with weak currencies will finance the balance of payments deficits
of large countries with more liquid currencies, even when investment returns are higher in the small
countries.
McKinnon’s article concludes with a special note on factor mobility. He recognizes the importance of
geographic factor mobility as described by Mundell, but also stresses the importance of industrial factor
mobility. He explains that factors do not need to migrate between geographic areas if they can migrate
between industries in the same area.
Kenen’s [1969] principal argument is that the economic diversification of an area may be more important
than factor mobility in determining optimal currency areas. He explains that a diversified economy will
be less affected by terms of trade shocks. Its resilience to such shocks increases with the extent of its
import-competitive industries and the industrial mobility of its production factors. He does not discuss
the effects of monetary unions on diversification, thereby implying that there are no limits to the size of a
diversified monetary area.
Kenen also notes the need for a liquid currency with a stable value to serve as the standard for allocating
capital among regions. He suggests that the currency of the largest region or the region with the best
monetary management would be converted to the inter-regional standard.
A. The Related Topic of Capital Markets
Ingram [1959] analyzes the balance of payments between North Carolina and other States in the U. S. He
finds that the availability of a large stock of tradable capital, i.e. federal government bonds, solves
transfer problems and other balance of payments pressures and could be more important than a single
currency in facilitating balance of payments adjustments. He notes that the establishment of the Federal
Reserve System coincided with the increased use of general government bonds by commercial banks (see
Table II). Ingram concludes that the development of an integrated capital market, mostly in the form of a
large stock of tradable capital units, eliminated regional payment pressures previously experienced in the
U. S. The existence of non-tradable capital units separates economic systems and produces balance of
payment pressures.
Local Currencies: Theories and Evidence
4
III. FISCAL FEDERALISM THEORY
In his classic book on fiscal federalism, Oates [1977/1972] explains the justification for assigning the
stabilization function to a central government. He says that the decentralization of the money supply
creates incentives for excessive monetary expansion that results in continually increasing inflation.
However, he does not explain how this incentive does not exist at the central level. Oates identifies some
of the same parameters used by the optimal currency area theorists, such as the importance of the non-
tradable sector and capital mobility.
Oates notes that local governments could use fiscal policy to stabilize, but offers reasons for why this is
likely to fail. He says that high consumption of imports renders weak local government fiscal stimuli,
such as reduced taxes. Like the optimal currency area theorists, Oates does not provide a guide for the
percentage of non-tradable consumption that would justify a local stabilization policy
3
. The Keynesian
model that Oates presents suffers from the fact that it does not quantify its assumptions of high marginal
and average propensities to import. Also, the model assumes perfect factor mobility within countries,
implying a single interest rate, which, in reality, exists in no state or country.
Oates also says that because of high capital mobility within countries, deficit financing by local
governments results in real income transfers to the exterior. However, he does not discuss the same case
for countries, nor does he consider the possibility that funds generated from the emission of local
government debt might be invested more efficiently and profitably (especially from the perspective of
local preferences) than those generated by a central government
4
. As Solomon [1996] indicates,
centralized currencies tend to support large-scale investments, for example in large infrastructure projects
and large companies.
On the other hand, the arguments that Oates uses to justify decentralization of other government functions
easily could be applied to monetary management. For example, the decentralization of monetary policy
could generate more experimentation and innovation in the provision of currencies. Also, the diversity of
preferences among various regions with respect to monetary policy could justify separate currencies. As
we will see below, the economic activity of certain regions within the U. S. varies enough to suppose that
the preferences of residents in those regions may vary enough to justify separate currencies.
On a related note, decentralization could open the door to more democratic monetary policies. Here, it
must be remembered that in the U. S., certain regions’ votes have more weight in Federal Reserve
decisions, and not all the regions with more voting weight represent more economic activity (this is due to
changes in the relative economic strengths of regions over time, which have not been updated in voting
weights). In addition, under dollarization, some regions are not represented at all. A common complaint
by opponents of the euro is that the institutions that manage the currency are not accountable to the
populations they supposedly serve.
By increasing exchange rate uncertainty and thereby increasing the cost of external trade, local currencies
favor local industries. The introduction of a local currency may be viewed as similar to the introduction
of a customs regime. For this reason, local currencies can be seen as a policy for satisfying
geographically interdependent utilities, as articulated by Pauly [1973]. He develops a model in which the
welfare of others determines the welfare of each individual. He adds a geographic component to express
the idea that the welfare of those closer to an individual is valued more than the welfare of those far away.
3
It may surprise many readers that in the U. S., more than a half of labor and production is oriented to internal state markets
(Krugman 1993).
4
This analysis should be revisited in light of the increased mobility of local government debt in recent years, thanks to certain
standard evaluation techniques and increased market information.
4
III. FISCAL FEDERALISM THEORY
In his classic book on fiscal federalism, Oates [1977/1972] explains the justification for assigning the
stabilization function to a central government. He says that the decentralization of the money supply
creates incentives for excessive monetary expansion that results in continually increasing inflation.
However, he does not explain how this incentive does not exist at the central level. Oates identifies some
of the same parameters used by the optimal currency area theorists, such as the importance of the non-
tradable sector and capital mobility.
Oates notes that local governments could use fiscal policy to stabilize, but offers reasons for why this is
likely to fail. He says that high consumption of imports renders weak local government fiscal stimuli,
such as reduced taxes. Like the optimal currency area theorists, Oates does not provide a guide for the
percentage of non-tradable consumption that would justify a local stabilization policy
3
. The Keynesian
model that Oates presents suffers from the fact that it does not quantify its assumptions of high marginal
and average propensities to import. Also, the model assumes perfect factor mobility within countries,
implying a single interest rate, which, in reality, exists in no state or country.
Oates also says that because of high capital mobility within countries, deficit financing by local
governments results in real income transfers to the exterior. However, he does not discuss the same case
for countries, nor does he consider the possibility that funds generated from the emission of local
government debt might be invested more efficiently and profitably (especially from the perspective of
local preferences) than those generated by a central government
4
. As Solomon [1996] indicates,
centralized currencies tend to support large-scale investments, for example in large infrastructure projects
and large companies.
On the other hand, the arguments that Oates uses to justify decentralization of other government functions
easily could be applied to monetary management. For example, the decentralization of monetary policy
could generate more experimentation and innovation in the provision of currencies. Also, the diversity of
preferences among various regions with respect to monetary policy could justify separate currencies. As
we will see below, the economic activity of certain regions within the U. S. varies enough to suppose that
the preferences of residents in those regions may vary enough to justify separate currencies.
On a related note, decentralization could open the door to more democratic monetary policies. Here, it
must be remembered that in the U. S., certain regions’ votes have more weight in Federal Reserve
decisions, and not all the regions with more voting weight represent more economic activity (this is due to
changes in the relative economic strengths of regions over time, which have not been updated in voting
weights). In addition, under dollarization, some regions are not represented at all. A common complaint
by opponents of the euro is that the institutions that manage the currency are not accountable to the
populations they supposedly serve.
By increasing exchange rate uncertainty and thereby increasing the cost of external trade, local currencies
favor local industries. The introduction of a local currency may be viewed as similar to the introduction
of a customs regime. For this reason, local currencies can be seen as a policy for satisfying
geographically interdependent utilities, as articulated by Pauly [1973]. He develops a model in which the
welfare of others determines the welfare of each individual. He adds a geographic component to express
the idea that the welfare of those closer to an individual is valued more than the welfare of those far away.
3
It may surprise many readers that in the U. S., more than a half of labor and production is oriented to internal state markets
(Krugman 1993).
4
This analysis should be revisited in light of the increased mobility of local government debt in recent years, thanks to certain
standard evaluation techniques and increased market information.
Local Currencies: Theories and Evidence
5
If residents of an area prefer to consume goods and services produced locally, implying employment of
local resources (including neighbors’ labor), it could be more efficient to introduce a local currency to
support local products.
Although he focuses on redistribution policy, the concepts of Tresch [1981] also can be used to justify
local currencies. Tresch says that each jurisdiction has its own welfare function and that policies should
satisfy these distinct functions. In his model, the welfare function of each level government is composed
of the welfare functions of those governments below it in the hierarchy, with the function of the lowest
level of government composed of individuals’ welfare functions. From this perspective, each level of
government should have its own currency if its welfare function is distinct from those of others with
respect to monetary policy. Local governments that share preferences or welfare functions for monetary
policy should share a single currency.
A. Relevant Studies
Tresch’s model, which firmly is part of fiscal federalism literature, has much in common with Alesina and
Grilli’s [1992] model in which differences in welfare from joining or abstaining from a currency union
depend on variations in preferences and income. They consider that preferences differ among regions and
that each region assesses the consequences of monetary policy in accord with its own welfare function.
They find that the less correlation between variations in income between a European country and the
European average, the worse off is a country under monetary union with Europe. This results from the
central bank stabilizing too much or too little.
Sachs and Sala-i-Martin [1992] observe that if a monetary union is aligned with a fiscal union, the fiscal
system can be used to counter asymmetric disturbances, including those caused by monetary policy. The
authors find that aligned fiscal and monetary systems facilitate inter-regional insurance in the sense that
all regions can finance the deficits of regions facing disturbances.
IV. ECONOMIC GROWTH THEORIES
One version of Bertola’s economic growth model [1993] predicts the disappearance of peripheral regions
after economic integration, due to the flight of capital and labor. Bertola solves this problem by
introducing the concept of interdependent technologies, in which the level of technology in each region
depends not only on its own investment, but also on investment in other regions. If local currencies
increase the level of local investment, they might help to sustain peripheral regions during and after
economic integration, although a model must be developed to assess the extent of these effects in the face
of decreased foreign investment due to costs associated with exchange rate uncertainty.
Krugman’s [1993] discussion of the case of the U. S. Commonwealth of Massachusetts as a possible
destiny for some European states is very relevant. He finds that U. S. regions that experience negative
demand shocks do not generally respond with decreases in the price level sufficient to attract new export
industries. Instead, regions simply shed labor and capital and never regain their previous output levels.
Krugman provides the example of California--where employment rose 86 percent relative to New York
during the period from 1960 to 1988 though the relative per capita income between the two states
remained unchanged. He adds that traditional manufacturing states have seen their employment shares
steadily decline since World War II.
The history of trade barriers in Europe leads Krugman to hypothesize that European economies are less
specialized than U. S. regions. Krugman finds that migration played very little role in European
countries, but that real wages indeed have adjusted over time. Changes in exchange rates have helped
5
If residents of an area prefer to consume goods and services produced locally, implying employment of
local resources (including neighbors’ labor), it could be more efficient to introduce a local currency to
support local products.
Although he focuses on redistribution policy, the concepts of Tresch [1981] also can be used to justify
local currencies. Tresch says that each jurisdiction has its own welfare function and that policies should
satisfy these distinct functions. In his model, the welfare function of each level government is composed
of the welfare functions of those governments below it in the hierarchy, with the function of the lowest
level of government composed of individuals’ welfare functions. From this perspective, each level of
government should have its own currency if its welfare function is distinct from those of others with
respect to monetary policy. Local governments that share preferences or welfare functions for monetary
policy should share a single currency.
A. Relevant Studies
Tresch’s model, which firmly is part of fiscal federalism literature, has much in common with Alesina and
Grilli’s [1992] model in which differences in welfare from joining or abstaining from a currency union
depend on variations in preferences and income. They consider that preferences differ among regions and
that each region assesses the consequences of monetary policy in accord with its own welfare function.
They find that the less correlation between variations in income between a European country and the
European average, the worse off is a country under monetary union with Europe. This results from the
central bank stabilizing too much or too little.
Sachs and Sala-i-Martin [1992] observe that if a monetary union is aligned with a fiscal union, the fiscal
system can be used to counter asymmetric disturbances, including those caused by monetary policy. The
authors find that aligned fiscal and monetary systems facilitate inter-regional insurance in the sense that
all regions can finance the deficits of regions facing disturbances.
IV. ECONOMIC GROWTH THEORIES
One version of Bertola’s economic growth model [1993] predicts the disappearance of peripheral regions
after economic integration, due to the flight of capital and labor. Bertola solves this problem by
introducing the concept of interdependent technologies, in which the level of technology in each region
depends not only on its own investment, but also on investment in other regions. If local currencies
increase the level of local investment, they might help to sustain peripheral regions during and after
economic integration, although a model must be developed to assess the extent of these effects in the face
of decreased foreign investment due to costs associated with exchange rate uncertainty.
Krugman’s [1993] discussion of the case of the U. S. Commonwealth of Massachusetts as a possible
destiny for some European states is very relevant. He finds that U. S. regions that experience negative
demand shocks do not generally respond with decreases in the price level sufficient to attract new export
industries. Instead, regions simply shed labor and capital and never regain their previous output levels.
Krugman provides the example of California--where employment rose 86 percent relative to New York
during the period from 1960 to 1988 though the relative per capita income between the two states
remained unchanged. He adds that traditional manufacturing states have seen their employment shares
steadily decline since World War II.
The history of trade barriers in Europe leads Krugman to hypothesize that European economies are less
specialized than U. S. regions. Krugman finds that migration played very little role in European
countries, but that real wages indeed have adjusted over time. Changes in exchange rates have helped
Local Currencies: Theories and Evidence
6
these adjustments. If Massachusetts had its own currency, real wages could have adjusted more easily to
accommodate increased investment.
In the discussion that follows Krugman’s chapter, Casella [1993] reminds us that trade-induced
specialization is the main source of gains from trade at any level. She notes that optimal portfolios could
be used to hedge against asymmetric shocks and that fiscal federalism can be viewed as a type of
insurance. She notes that in Italy, transfers from the north to the south are seen by many as a counter-
migratory force intended to avoid social tensions. Casella reminds us that Blanchard and Katz’s [1992]
migration-led model does not explain the fact that after negative employment shocks, U. S. house prices
decline sharply but return to their previous prices over time, which does not comport with the vision of
regional economies in decline. Casella fears that Europe will not develop like the U. S., but instead
industry-specific shocks will cause high unemployment, without labor mobility or wage adjustment.
V. OTHER MODELS AND STUDIES
Eichengreen [1992] identifies the following possible responses to a regional shift in demand:
Domestic wage and price adjustments;
Interregional migration;
Interregional flows of private and public capital; and
Interregional fiscal transfers.
He asserts that spending by governments can offset relative decreases in demand, but notes that
government spending ability will be limited by its capacity to issue debt, which will be reduced by
increased factor mobility. Deficit spending will increase domestic and international interest rates, leading
to an international sharing of the costs of deficit financing. Eichengreen also notes that the creation of a
single market does not require a single currency [Eichengreen 1992].
Bayoumi and Eichengreen [1993] review several empirical studies that find that the U. S. adjusted more
quickly to region-specific shocks than pre-euro Europe, whether by market or policy. In their own study,
they find that fluctuations in output have been smaller among EC countries while fluctuations in inflation
have been smaller among U. S. regions. However, output growth in the Southwest and Rocky Mountain
regions of the U. S. has been idiosyncratic due to regional economic dependence on oil for the former and
minerals for the latter. They later note that large idiosyncratic shocks support the case for independent
monetary policy. They also find higher correlation among regional demand disturbances for the U. S.
than for Europe and note that the higher correlation may result from uniform economic policies. They
observe that peripheral countries in the EC sustain supply shocks twice as large as the central ‘core’.
They warn that the completion of Europe’s internal market may exacerbate regional demand disturbances
by fostering specialization. They point to higher factor mobility in the U. S. as the likely explanation of
faster impulse-response functions in the U. S. than Europe.
In the Discussion that follows Bayoumi and Eichengreen’s chapter, Minford [1993] notes the subjectivity
of the authors’ technique of comparing regional output and demand correlation to a central, ‘core’ , region
(Germany for Europe and the Mideast for the U. S.). Minford proposes that there may be sub-regions,
such as Britain-Ireland or Germany-Benelux, that may present themselves as optimal currency areas.
Minford also notes that less mobile labor in Europe provides more stable tax bases on which to base fiscal
stabilization.
Schmitt-Grohe and Uribe [2000] measured the welfare costs of various monetary regimes for the case of
Mexico. They determined that the best regime would be an individual central bank that devalued as
world interest rates rose, terms of trade declined or the inflation rate of imports declined. They found
6
these adjustments. If Massachusetts had its own currency, real wages could have adjusted more easily to
accommodate increased investment.
In the discussion that follows Krugman’s chapter, Casella [1993] reminds us that trade-induced
specialization is the main source of gains from trade at any level. She notes that optimal portfolios could
be used to hedge against asymmetric shocks and that fiscal federalism can be viewed as a type of
insurance. She notes that in Italy, transfers from the north to the south are seen by many as a counter-
migratory force intended to avoid social tensions. Casella reminds us that Blanchard and Katz’s [1992]
migration-led model does not explain the fact that after negative employment shocks, U. S. house prices
decline sharply but return to their previous prices over time, which does not comport with the vision of
regional economies in decline. Casella fears that Europe will not develop like the U. S., but instead
industry-specific shocks will cause high unemployment, without labor mobility or wage adjustment.
V. OTHER MODELS AND STUDIES
Eichengreen [1992] identifies the following possible responses to a regional shift in demand:
Domestic wage and price adjustments;
Interregional migration;
Interregional flows of private and public capital; and
Interregional fiscal transfers.
He asserts that spending by governments can offset relative decreases in demand, but notes that
government spending ability will be limited by its capacity to issue debt, which will be reduced by
increased factor mobility. Deficit spending will increase domestic and international interest rates, leading
to an international sharing of the costs of deficit financing. Eichengreen also notes that the creation of a
single market does not require a single currency [Eichengreen 1992].
Bayoumi and Eichengreen [1993] review several empirical studies that find that the U. S. adjusted more
quickly to region-specific shocks than pre-euro Europe, whether by market or policy. In their own study,
they find that fluctuations in output have been smaller among EC countries while fluctuations in inflation
have been smaller among U. S. regions. However, output growth in the Southwest and Rocky Mountain
regions of the U. S. has been idiosyncratic due to regional economic dependence on oil for the former and
minerals for the latter. They later note that large idiosyncratic shocks support the case for independent
monetary policy. They also find higher correlation among regional demand disturbances for the U. S.
than for Europe and note that the higher correlation may result from uniform economic policies. They
observe that peripheral countries in the EC sustain supply shocks twice as large as the central ‘core’.
They warn that the completion of Europe’s internal market may exacerbate regional demand disturbances
by fostering specialization. They point to higher factor mobility in the U. S. as the likely explanation of
faster impulse-response functions in the U. S. than Europe.
In the Discussion that follows Bayoumi and Eichengreen’s chapter, Minford [1993] notes the subjectivity
of the authors’ technique of comparing regional output and demand correlation to a central, ‘core’ , region
(Germany for Europe and the Mideast for the U. S.). Minford proposes that there may be sub-regions,
such as Britain-Ireland or Germany-Benelux, that may present themselves as optimal currency areas.
Minford also notes that less mobile labor in Europe provides more stable tax bases on which to base fiscal
stabilization.
Schmitt-Grohe and Uribe [2000] measured the welfare costs of various monetary regimes for the case of
Mexico. They determined that the best regime would be an individual central bank that devalued as
world interest rates rose, terms of trade declined or the inflation rate of imports declined. They found
Local Currencies: Theories and Evidence
7
dollarization to be the most costly choice of monetary regime. They state that "…if the monetary
authority could respond to the adverse interest rate shock by devaluing the domestic currency, then the
relative price of non-tradable goods and services would be allowed to fall, making the adjustment of the
sticky price economy more akin to that of a flexible-price economy."
VI. SOME OBSERVATIONS
Optimal currency area theory leaves many unanswered questions. One issue that comes from
McKinnon’s article and continues unsolved in the rest is that of factor mobility. The theorists tell us that
the level of factor mobility is a determinant of an optimal currency area. However, separate currencies
increase transaction costs and thereby decrease factor mobility, whereas the replacement of separate
currencies with a single currency increases factor mobility. Obviously, other variables influence factor
mobility, such as technology, language, culture and transportation infrastructure, but the endogeneity of
factor mobility to optimal size of currency areas should be addressed.
Economic diversification presents a similar problem. The theorists tell us that more economically diverse
areas justify single currencies more than less diverse areas. However, empirical research suggests that the
introduction of a separate currency likely increases the economic diversification of an area.
Monetary and economic integration, while related, are not equal. A single market, based on common
laws, transportation networks and free trade, does not require a single currency. Equally, a common
currency does not imply a common market, as currently seen in Europe or among dollarized economies.
Local currencies can be seen as a type of trade barrier. Every economy maintains some type of trade
barriers, whether through direct support to certain industries, preferential tax treatment or free trade
agreements. From one perspective, the costs of maintaining a local currency should be compared to other
forms of protectionism.
The decision to adopt a foreign currency or join a currency union many times is made in reaction to poor
monetary management. This is especially true in the case of dollarization. Models that aim to determine
optimal monetary regimes must consider the very real costs of poor monetary management. Policies that
aim to reach optimal monetary regimes should weigh the costs of adopting a foreign currency in relation
to improving domestic monetary management.
VII. CASE STUDY: THE COMMONWEALTH OF INDEPENDENT STATES
Recently, the world has witnessed the birth of a huge currency area, the euro zone, and the expansion of
another, through dollarization. However, it also has witnessed the dissolution of the large ruble zone into
several smaller currency areas. This section examines the economic characteristics of the Commonwealth
of Independent States (CIS), representing most of the former ruble zone, in an attempt to determine if the
maintenance of the smaller currency areas is efficient or if there are some gains to be made from monetary
unification, either among CIS countries or through dollarization. First, an economic model is developed.
Then, empirical evidence from the CIS and the U. S. is presented. Section VIII continues with a specific
focus on the case of Armenia.
Borrowing from Alesina and Grilli [1992], it is assumed that the central bank determines monetary policy
based on an inflation target that reacts to shocks in the previous period. The objective of the CIS central
bank is to minimize its losses, represented by the following function:
(1) LCIS = ½ E[
2
CIS + b(xCIS – x
*
CIS)
2
].
7
dollarization to be the most costly choice of monetary regime. They state that "…if the monetary
authority could respond to the adverse interest rate shock by devaluing the domestic currency, then the
relative price of non-tradable goods and services would be allowed to fall, making the adjustment of the
sticky price economy more akin to that of a flexible-price economy."
VI. SOME OBSERVATIONS
Optimal currency area theory leaves many unanswered questions. One issue that comes from
McKinnon’s article and continues unsolved in the rest is that of factor mobility. The theorists tell us that
the level of factor mobility is a determinant of an optimal currency area. However, separate currencies
increase transaction costs and thereby decrease factor mobility, whereas the replacement of separate
currencies with a single currency increases factor mobility. Obviously, other variables influence factor
mobility, such as technology, language, culture and transportation infrastructure, but the endogeneity of
factor mobility to optimal size of currency areas should be addressed.
Economic diversification presents a similar problem. The theorists tell us that more economically diverse
areas justify single currencies more than less diverse areas. However, empirical research suggests that the
introduction of a separate currency likely increases the economic diversification of an area.
Monetary and economic integration, while related, are not equal. A single market, based on common
laws, transportation networks and free trade, does not require a single currency. Equally, a common
currency does not imply a common market, as currently seen in Europe or among dollarized economies.
Local currencies can be seen as a type of trade barrier. Every economy maintains some type of trade
barriers, whether through direct support to certain industries, preferential tax treatment or free trade
agreements. From one perspective, the costs of maintaining a local currency should be compared to other
forms of protectionism.
The decision to adopt a foreign currency or join a currency union many times is made in reaction to poor
monetary management. This is especially true in the case of dollarization. Models that aim to determine
optimal monetary regimes must consider the very real costs of poor monetary management. Policies that
aim to reach optimal monetary regimes should weigh the costs of adopting a foreign currency in relation
to improving domestic monetary management.
VII. CASE STUDY: THE COMMONWEALTH OF INDEPENDENT STATES
Recently, the world has witnessed the birth of a huge currency area, the euro zone, and the expansion of
another, through dollarization. However, it also has witnessed the dissolution of the large ruble zone into
several smaller currency areas. This section examines the economic characteristics of the Commonwealth
of Independent States (CIS), representing most of the former ruble zone, in an attempt to determine if the
maintenance of the smaller currency areas is efficient or if there are some gains to be made from monetary
unification, either among CIS countries or through dollarization. First, an economic model is developed.
Then, empirical evidence from the CIS and the U. S. is presented. Section VIII continues with a specific
focus on the case of Armenia.
Borrowing from Alesina and Grilli [1992], it is assumed that the central bank determines monetary policy
based on an inflation target that reacts to shocks in the previous period. The objective of the CIS central
bank is to minimize its losses, represented by the following function:
(1) LCIS = ½ E[
2
CIS + b(xCIS – x
*
CIS)
2
].
Local Currencies: Theories and Evidence
8
LCIS is a loss function that depends on the CIS inflation rate, CIS, and the deviation of CIS output, xCIS,
from a given level, x
*
CIS. Output is determined by the Phillips curve relation:
(2) xCIS = (CIS –
e
CIS) + ,
in which deviations from a normal level of output yi = 0 depend on unexpected inflation. For this reason,
it is in the central bank’s interest to generate unexpected inflation. The partial derivative of output with
respect to unexpected inflation is set equal to 1. The term is a random shock with mean 0 and variance
2
. The time-consistent inflation policy is represented by:
(3) CIS = bx
*
CIS – [b/(1 + b)].
This is found by substituting the output function into the preferences function, then taking first order
conditions with respect to CIS and imposing the conditions of rationality of expectations. This function
assumes that the central bank controls inflation. A more realistic assumption would be that the central
bank controls the money supply. This would be expressed with a quantity expression that would do
nothing more than complicate the algebra without providing any additional information. So, we will stick
with the assumption that the central bank controls inflation.
The term bx
*
CIS implies that the average inflation rate is greater than 0. The first-best policy that would
eliminate the inflation bias presented by this term and would not reduce output stability would be:
(4) CIS = - [ b /(1 + b)].
This is the inflation policy the central bank would follow if it could make a credible commitment to it.
However, since the central bank has an incentive to generate unexpected inflation which results in
increases in output, this policy is not credible. The parameter that represents this tradeoff between
average inflation and variance of output is b. This parameter is determined by the central bank and
should reflect the preferences of its constituency. The lower it is, the lower is average inflation, but the
higher is output variance which is represented by:
(5)
2
x = [
2
/(1 + b)
2
].
From this equation, we can see clearly that if b = 0, the inflation bias is eliminated, but no stabilization is
achieved (
2
x =
2
) so the variance of the shock is completely transmitted to output.
The output level for this model is:
(6) xCIS = [1/(1 + b)].
Now, we introduced the concept of independent states to the model. It is assumed that each country
evaluates monetary policy based on its own national welfare function:
(7) L
i
= ½ E[
2
CIS + (yi – y
*
i)
2
],
Where
(8) yi = (CIS –
e
CIS) + I,
8
LCIS is a loss function that depends on the CIS inflation rate, CIS, and the deviation of CIS output, xCIS,
from a given level, x
*
CIS. Output is determined by the Phillips curve relation:
(2) xCIS = (CIS –
e
CIS) + ,
in which deviations from a normal level of output yi = 0 depend on unexpected inflation. For this reason,
it is in the central bank’s interest to generate unexpected inflation. The partial derivative of output with
respect to unexpected inflation is set equal to 1. The term is a random shock with mean 0 and variance
2
. The time-consistent inflation policy is represented by:
(3) CIS = bx
*
CIS – [b/(1 + b)].
This is found by substituting the output function into the preferences function, then taking first order
conditions with respect to CIS and imposing the conditions of rationality of expectations. This function
assumes that the central bank controls inflation. A more realistic assumption would be that the central
bank controls the money supply. This would be expressed with a quantity expression that would do
nothing more than complicate the algebra without providing any additional information. So, we will stick
with the assumption that the central bank controls inflation.
The term bx
*
CIS implies that the average inflation rate is greater than 0. The first-best policy that would
eliminate the inflation bias presented by this term and would not reduce output stability would be:
(4) CIS = - [ b /(1 + b)].
This is the inflation policy the central bank would follow if it could make a credible commitment to it.
However, since the central bank has an incentive to generate unexpected inflation which results in
increases in output, this policy is not credible. The parameter that represents this tradeoff between
average inflation and variance of output is b. This parameter is determined by the central bank and
should reflect the preferences of its constituency. The lower it is, the lower is average inflation, but the
higher is output variance which is represented by:
(5)
2
x = [
2
/(1 + b)
2
].
From this equation, we can see clearly that if b = 0, the inflation bias is eliminated, but no stabilization is
achieved (
2
x =
2
) so the variance of the shock is completely transmitted to output.
The output level for this model is:
(6) xCIS = [1/(1 + b)].
Now, we introduced the concept of independent states to the model. It is assumed that each country
evaluates monetary policy based on its own national welfare function:
(7) L
i
= ½ E[
2
CIS + (yi – y
*
i)
2
],
Where
(8) yi = (CIS –
e
CIS) + I,
Local Currencies: Theories and Evidence
9
which represents the output of a given country, i, and i is a country-specific shock. Alesina and Grilli
assumed that inflation – C – is the same in all countries since all countries are in the same currency
union. Substituting the equations yields:
(9) L
i
= ½ E{[bx
*
CIS – [b/(1 + b)]]
2
+ [i – [b/(1 + b)]] – y
*
i]
2
},
which is the welfare that country i derives from the central bank’s monetary policy. If each country were
to maintain its own monetary policy, then the national central bank policies would be represented by:
(10) i = i y
*
i – [i/(1 + i)]i.
The related output level is:
(11) yi = [1/(1 + i)]i.
So, the loss is:
(12) L
i
N = ½ E{[ iy
*
i – [ i/(1 + i)]i]
2
+ [[ i/(1 + i)]i] – y
*
i]
2
}.
Therefore, the loss caused by a difference between a single CIS monetary policy and individual national
monetary policies is:
(13) L
i
– L
i
N = ½ {x
*2
(b
2
- i
2
) + (1 + i)[[b/(1 + b)]
2
2
– [i/(1 + i)]
2
2
]
– 2i[[b/(1 + b)] – [i/(1 + i)]
2
},
where
2
= variance of i ,
= covariance between i and and
x
*
CIS = y
*
i x
*
.
If there are no economic differences among the different countries, then
2
=
2
=
2
, and:
(14) L
i
– L
i
N = ½ {x
*2
(b
2
- i
2
) +
2
[[b/(1 + b)] – [i/(1 + i)]][[(1 + i)/ (1 + b)]b – i]}.
So, if the CIS central bank was more conservative than an individual country’s, that country would
experience credibility gains from joining the currency union. In this respect, countries with higher
inflation rates would have more to gain from joining the union.
If there are no political differences, then i = b and x
*
CIS = y
*
i. In this case:
(15) L
i
– L
i
N = ½ {[b
2
/(1 + b)][
2
+
2
– 2i]},
where i is the correlation coefficient between i and . If i = 1, then:
(16) L
i
– L
i
N = ½ {[b
2
/(1 + b)][ – ]
2
}.
So, if there are differences in CIS and national output variance, the country will lose welfare in a
monetary union. If output is correlated, but not perfectly, then:
(17) L
i
– L
i
N = ½ {[b
2
/(1 + b)]
2
(1 – i]}.
9
which represents the output of a given country, i, and i is a country-specific shock. Alesina and Grilli
assumed that inflation – C – is the same in all countries since all countries are in the same currency
union. Substituting the equations yields:
(9) L
i
= ½ E{[bx
*
CIS – [b/(1 + b)]]
2
+ [i – [b/(1 + b)]] – y
*
i]
2
},
which is the welfare that country i derives from the central bank’s monetary policy. If each country were
to maintain its own monetary policy, then the national central bank policies would be represented by:
(10) i = i y
*
i – [i/(1 + i)]i.
The related output level is:
(11) yi = [1/(1 + i)]i.
So, the loss is:
(12) L
i
N = ½ E{[ iy
*
i – [ i/(1 + i)]i]
2
+ [[ i/(1 + i)]i] – y
*
i]
2
}.
Therefore, the loss caused by a difference between a single CIS monetary policy and individual national
monetary policies is:
(13) L
i
– L
i
N = ½ {x
*2
(b
2
- i
2
) + (1 + i)[[b/(1 + b)]
2
2
– [i/(1 + i)]
2
2
]
– 2i[[b/(1 + b)] – [i/(1 + i)]
2
},
where
2
= variance of i ,
= covariance between i and and
x
*
CIS = y
*
i x
*
.
If there are no economic differences among the different countries, then
2
=
2
=
2
, and:
(14) L
i
– L
i
N = ½ {x
*2
(b
2
- i
2
) +
2
[[b/(1 + b)] – [i/(1 + i)]][[(1 + i)/ (1 + b)]b – i]}.
So, if the CIS central bank was more conservative than an individual country’s, that country would
experience credibility gains from joining the currency union. In this respect, countries with higher
inflation rates would have more to gain from joining the union.
If there are no political differences, then i = b and x
*
CIS = y
*
i. In this case:
(15) L
i
– L
i
N = ½ {[b
2
/(1 + b)][
2
+
2
– 2i]},
where i is the correlation coefficient between i and . If i = 1, then:
(16) L
i
– L
i
N = ½ {[b
2
/(1 + b)][ – ]
2
}.
So, if there are differences in CIS and national output variance, the country will lose welfare in a
monetary union. If output is correlated, but not perfectly, then:
(17) L
i
– L
i
N = ½ {[b
2
/(1 + b)]
2
(1 – i]}.
Local Currencies: Theories and Evidence
10
So, the smaller the correlation between i and the worse off is country i under monetary union.
Table III shows the standard deviation and correlation of GDP growth rates among CIS countries. The
data shows that Russia, Kazakstan, Belarus and Ukraine would benefit most from a CIS-wide currency,
whereas Tajikistan, Turkmenistan and the countries of the Caucasus region would benefit least.
Regression analysis shows that the percentage of value added to GDP by the agriculture sector and a
dummy variable for the Caucasus region explained more than 80 percent of the relative deviation in
output among CIS countries
5
. This finding may lend weight to McKinnon’s [1963] focus on industrial
factor mobility, if it is determined that mobility between the agriculture sector and other sectors such as
manufacturing, industry and services, is low. The finding also is in line with Bayoumi and Eichengreen’s
[1993] assertion that the Rocky Mountain and Southwest regions of the U. S. are less well suited for
monetary union with the rest of the country because of their dependence on the petroleum and mineral
industries that are less prevalent in other regions.
Table IV shows the same figures as Table III, but for regions of the U. S. It is interesting to note that
many of the CIS countries are economically closer to each other than regions of the U. S., in terms of both
standard deviation and correlation of output.
If the countries of the CIS, or at least some of them, are economically closer to each other than the regions
of the U. S., why do they maintain their own currencies? At least part of this answer lies in the political
arena. However, there are economic answers as well. By maintaining their own currencies, these
countries gain seignorage and other economic benefits. A closer look at the case of Armenia reveals
some of these.
VIII. FOCUS ON ARMENIA
Armenia is an interesting case study for many reasons. It is a very small area with a small population, so
lessons learned about the benefits of its currency reveal parameters at the other end of the spectrum from
those used to justify the expansion of the euro and dollar areas, on which most recent literature has
focused. It has a floating exchange rate. And, other currencies, including the dollar, are very present in
the economy.
The Armenian dram certainly is not a vehicle currency and even within its own area, it is not used as the
primary store of value. Only 25 percent of bank deposits in Armenia are dram accounts; the majority is
foreign currency accounts, mostly U. S. dollar accounts [IMF October 2002]. Poghosyan [2003] finds
that the impact of domestic interest rates on domestic money demand is insignificant, which indicates that
the dram is not generally used for saving. This finding is in line with McKinnon’s [1963] theory that
savers will demand more of another currency if their own currency is used in only a small area. This
finding also is related to past inflation rates, which were signaled by McKinnon as a reason for
demanding another currency. Poghosyan finds a limited response in the demand for money with respect
to prices (20 percent) and explains this by the high sensitivity of prices to the dram exchange rate. He
concludes that a price increase indicates a dram depreciation, causing a flight from the dram and further
dollarization of the economy.
Within the Armenian economy, the dollar commonly is used as a unit of account, often in parallel with
the dram. Even small denominations of dollar bills (including $1 bills) are highly prevalent, at least in the
5
See Statistical Annex for details. Turkmenistan and Tajikistan were omitted for lack of data.
10
So, the smaller the correlation between i and the worse off is country i under monetary union.
Table III shows the standard deviation and correlation of GDP growth rates among CIS countries. The
data shows that Russia, Kazakstan, Belarus and Ukraine would benefit most from a CIS-wide currency,
whereas Tajikistan, Turkmenistan and the countries of the Caucasus region would benefit least.
Regression analysis shows that the percentage of value added to GDP by the agriculture sector and a
dummy variable for the Caucasus region explained more than 80 percent of the relative deviation in
output among CIS countries
5
. This finding may lend weight to McKinnon’s [1963] focus on industrial
factor mobility, if it is determined that mobility between the agriculture sector and other sectors such as
manufacturing, industry and services, is low. The finding also is in line with Bayoumi and Eichengreen’s
[1993] assertion that the Rocky Mountain and Southwest regions of the U. S. are less well suited for
monetary union with the rest of the country because of their dependence on the petroleum and mineral
industries that are less prevalent in other regions.
Table IV shows the same figures as Table III, but for regions of the U. S. It is interesting to note that
many of the CIS countries are economically closer to each other than regions of the U. S., in terms of both
standard deviation and correlation of output.
If the countries of the CIS, or at least some of them, are economically closer to each other than the regions
of the U. S., why do they maintain their own currencies? At least part of this answer lies in the political
arena. However, there are economic answers as well. By maintaining their own currencies, these
countries gain seignorage and other economic benefits. A closer look at the case of Armenia reveals
some of these.
VIII. FOCUS ON ARMENIA
Armenia is an interesting case study for many reasons. It is a very small area with a small population, so
lessons learned about the benefits of its currency reveal parameters at the other end of the spectrum from
those used to justify the expansion of the euro and dollar areas, on which most recent literature has
focused. It has a floating exchange rate. And, other currencies, including the dollar, are very present in
the economy.
The Armenian dram certainly is not a vehicle currency and even within its own area, it is not used as the
primary store of value. Only 25 percent of bank deposits in Armenia are dram accounts; the majority is
foreign currency accounts, mostly U. S. dollar accounts [IMF October 2002]. Poghosyan [2003] finds
that the impact of domestic interest rates on domestic money demand is insignificant, which indicates that
the dram is not generally used for saving. This finding is in line with McKinnon’s [1963] theory that
savers will demand more of another currency if their own currency is used in only a small area. This
finding also is related to past inflation rates, which were signaled by McKinnon as a reason for
demanding another currency. Poghosyan finds a limited response in the demand for money with respect
to prices (20 percent) and explains this by the high sensitivity of prices to the dram exchange rate. He
concludes that a price increase indicates a dram depreciation, causing a flight from the dram and further
dollarization of the economy.
Within the Armenian economy, the dollar commonly is used as a unit of account, often in parallel with
the dram. Even small denominations of dollar bills (including $1 bills) are highly prevalent, at least in the
5
See Statistical Annex for details. Turkmenistan and Tajikistan were omitted for lack of data.
Local Currencies: Theories and Evidence
11
capital city. So, why is the dram in use? If Armenians are using the dollar as a store of value and, at least
to some extent, as a unit of account, why doesn’t the country simply adopt the dollar as its currency?
One reason Armenia should not adopt the dollar is apparent in Table V, which is the same as Table IV
except for its inclusion of data for Armenia. The standard deviation of Armenia from U. S. growth rates
is more than nine times the next greatest deviation, that of the Far West, and its correlation with the U. S.
is equal to the lowest correlation among U. S. regions.
The high rate of inflation experienced in Armenia during the past 15 years provides an argument in favor
of dollarization. Average inflation during the 1990 – 2001 period was 819 percent. However, most of
this was experienced in the beginning of the country’s economic transition and inflation has subsided in
recent years. For 2000, it was negative and in 2001 it was a moderate 3.2 percent. The current long run
elasticity of dram demand with respect to income is greater than 1, indicating increased use of the dram
throughout the economy. As noted above, the elasticity of dram demand with respect to prices is a mere
0.2, indicating that increased prices lead to flight from the dram and increased dollarization [Poghosyan
2003]. So, economic agents adjust their portfolios depending on economic indicators. They switch from
the dram to the dollar depending on prevailing conditions. This is the best situation in that it allows
individual agents to use the currency that best suits them, versus a rigid policy of dollarization which
would eliminate this very important choice for agents in the Armenian economy.
IX. CONCLUSIONS
The issue of monetary policy and optimal currency unions is an issue of federalism. The choice of
whether to adopt another country’s currency, to join a currency union or to issue an independent currency
is a choice of which level of government should be assigned responsibility for monetary policy. Further,
the issue is an issue of international federalism, since many currencies now serve more than one country.
The use of a stable, international currency can help countries with poor monetary management and
countries in transition. However, the complete reliance on an international currency may fail to satisfy
local preferences and may depress local economic activity. The increased use of the Armenian dram
demonstrates that demand for local currencies exists, even when they are not the main store of value.
Many of the CIS countries are economically closer to each other than regions of the U. S., in terms of
both standard deviation and correlation of output. There is some evidence that at least Russia, Kazakstan,
Belarus and Ukraine might benefit from a monetary union, whereas many regions in the U. S. might
benefit from issuing their own currencies.
Local currencies are associated with economic growth, as evidenced by the long-run demand elasticity
with respect to GDP for the Armenian dram. Countries that do not provide a local currency or otherwise
ensure liquidity in the local economy may be inhibiting economic growth. The existence of demand for
the dram and the fact that Armenia has sustained its own currency, in spite of its population of fewer than
4 million people and its de facto integration in the dollar zone, at least in terms of savings, begs the
question of whether there exists demand for local currencies within other large currency unions, such as
regions of Europe and the U. S.
There is ample room for more studies in this area. For the case of Armenia and the CIS, the following
issues should be incorporated in the amplification of this investigation:
The influence of trade flows on the relative deviation of output from the CIS;
11
capital city. So, why is the dram in use? If Armenians are using the dollar as a store of value and, at least
to some extent, as a unit of account, why doesn’t the country simply adopt the dollar as its currency?
One reason Armenia should not adopt the dollar is apparent in Table V, which is the same as Table IV
except for its inclusion of data for Armenia. The standard deviation of Armenia from U. S. growth rates
is more than nine times the next greatest deviation, that of the Far West, and its correlation with the U. S.
is equal to the lowest correlation among U. S. regions.
The high rate of inflation experienced in Armenia during the past 15 years provides an argument in favor
of dollarization. Average inflation during the 1990 – 2001 period was 819 percent. However, most of
this was experienced in the beginning of the country’s economic transition and inflation has subsided in
recent years. For 2000, it was negative and in 2001 it was a moderate 3.2 percent. The current long run
elasticity of dram demand with respect to income is greater than 1, indicating increased use of the dram
throughout the economy. As noted above, the elasticity of dram demand with respect to prices is a mere
0.2, indicating that increased prices lead to flight from the dram and increased dollarization [Poghosyan
2003]. So, economic agents adjust their portfolios depending on economic indicators. They switch from
the dram to the dollar depending on prevailing conditions. This is the best situation in that it allows
individual agents to use the currency that best suits them, versus a rigid policy of dollarization which
would eliminate this very important choice for agents in the Armenian economy.
IX. CONCLUSIONS
The issue of monetary policy and optimal currency unions is an issue of federalism. The choice of
whether to adopt another country’s currency, to join a currency union or to issue an independent currency
is a choice of which level of government should be assigned responsibility for monetary policy. Further,
the issue is an issue of international federalism, since many currencies now serve more than one country.
The use of a stable, international currency can help countries with poor monetary management and
countries in transition. However, the complete reliance on an international currency may fail to satisfy
local preferences and may depress local economic activity. The increased use of the Armenian dram
demonstrates that demand for local currencies exists, even when they are not the main store of value.
Many of the CIS countries are economically closer to each other than regions of the U. S., in terms of
both standard deviation and correlation of output. There is some evidence that at least Russia, Kazakstan,
Belarus and Ukraine might benefit from a monetary union, whereas many regions in the U. S. might
benefit from issuing their own currencies.
Local currencies are associated with economic growth, as evidenced by the long-run demand elasticity
with respect to GDP for the Armenian dram. Countries that do not provide a local currency or otherwise
ensure liquidity in the local economy may be inhibiting economic growth. The existence of demand for
the dram and the fact that Armenia has sustained its own currency, in spite of its population of fewer than
4 million people and its de facto integration in the dollar zone, at least in terms of savings, begs the
question of whether there exists demand for local currencies within other large currency unions, such as
regions of Europe and the U. S.
There is ample room for more studies in this area. For the case of Armenia and the CIS, the following
issues should be incorporated in the amplification of this investigation:
The influence of trade flows on the relative deviation of output from the CIS;
Local Currencies: Theories and Evidence
12
The relationship between local money supply and the employment share of individual countries
within the CIS;
The relative deviation of Armenia from its non-CIS neighbors, Iran and Turkey;
The efficiency of a Caucasus currency union comprised of Azerbaijan, Armenia and Georgia.
12
The relationship between local money supply and the employment share of individual countries
within the CIS;
The relative deviation of Armenia from its non-CIS neighbors, Iran and Turkey;
The efficiency of a Caucasus currency union comprised of Azerbaijan, Armenia and Georgia.
Local Currencies: Theories and Evidence
13
STATISTICAL APPENDIX
GROWTH RATES FOR THE COMMONWEALTH OF INDEPENDENT STATES, 1989 - 2001
CIS Armenia Azerbaijan Belarus Georgia Kazakstan Kyrgyzstan Moldova Russia Tajikistan Turkmenistan Ukraine Uzbekistan
1989 1.9 8.5 -8.8 8.2 -3.5 -0.1 4.6 8.8 1.6 1349.3 1233.3 5.0 31.6
1990 -3.2 -5.5 -11.7 -1.9 -15.1 -1.0 4.8 -2.4 -3.0 0.2 1.8 -3.6 -0.8
1991 -6.1 -11.7 -0.7 -1.2 -21.1 -10.9 -7.9 -17.5 -4.9 -8.5 -4.7 -8.7 -0.5
1992 -
14.2
-41.7 -22.6 -9.6 -44.9 -5.3 -13.8 -28.9 -14.5 -32.3 -14.9 -9.9 -11.1
1993 -9.7 -8.8 -23.1 -7.5 -29.3 -9.2 -15.5 -1.2 -8.8 -16.3 1.5 -14.2 -2.3
1994 -
14.3
5.4 -19.7 -12.6 -10.3 -12.7 -20.1 -31.0 -12.7 -21.3 -17.3 -22.9 -5.3
1995 -5.6 6.9 -11.7 -10.5 2.6 -8.2 -5.5 -1.3 -4.1 -12.5 -7.2 -12.2 -0.9
1996 -3.3 5.8 1.1 2.8 11.3 0.5 7.2 -6.0 -3.3 -16.8 6.7 -10.0 1.7
1997 1.1 3.4 5.9 11.3 10.5 1.6 9.8 1.7 0.9 1.7 -11.4 -2.9 5.1
1998 -2.9 7.3 10.1 8.4 2.7 -1.9 2.2 -6.5 -4.9 5.6 7.1 -2.0 4.4
1999 4.4 3.2 7.3 3.4 3.0 2.8 3.6 -3.5 5.4 3.4 16.9 -0.3 4.4
2000 8.3 6.0 11.1 5.8 2.2 9.7 5.4 2.4 9.0 8.5 17.6 5.9 3.9
2001 6.2 9.7 9.8 4.1 4.4 13.2 5.3 5.9 5.0 10.0 20.5 9.1 4.5
Avg: -2.9 -0.9 -4.1 0.1 -6.7 -1.6 -1.5 -6.1 -2.6 97.8 96.1 -5.1 2.7
stddev: 7.22 14.03 12.85 7.95 16.73 7.69 9.85 12.37 6.96 376.25 341.91 9.03 9.86
Source: Economic Survey of Europe (UNECE 2002)
13
STATISTICAL APPENDIX
GROWTH RATES FOR THE COMMONWEALTH OF INDEPENDENT STATES, 1989 - 2001
CIS Armenia Azerbaijan Belarus Georgia Kazakstan Kyrgyzstan Moldova Russia Tajikistan Turkmenistan Ukraine Uzbekistan
1989 1.9 8.5 -8.8 8.2 -3.5 -0.1 4.6 8.8 1.6 1349.3 1233.3 5.0 31.6
1990 -3.2 -5.5 -11.7 -1.9 -15.1 -1.0 4.8 -2.4 -3.0 0.2 1.8 -3.6 -0.8
1991 -6.1 -11.7 -0.7 -1.2 -21.1 -10.9 -7.9 -17.5 -4.9 -8.5 -4.7 -8.7 -0.5
1992 -
14.2
-41.7 -22.6 -9.6 -44.9 -5.3 -13.8 -28.9 -14.5 -32.3 -14.9 -9.9 -11.1
1993 -9.7 -8.8 -23.1 -7.5 -29.3 -9.2 -15.5 -1.2 -8.8 -16.3 1.5 -14.2 -2.3
1994 -
14.3
5.4 -19.7 -12.6 -10.3 -12.7 -20.1 -31.0 -12.7 -21.3 -17.3 -22.9 -5.3
1995 -5.6 6.9 -11.7 -10.5 2.6 -8.2 -5.5 -1.3 -4.1 -12.5 -7.2 -12.2 -0.9
1996 -3.3 5.8 1.1 2.8 11.3 0.5 7.2 -6.0 -3.3 -16.8 6.7 -10.0 1.7
1997 1.1 3.4 5.9 11.3 10.5 1.6 9.8 1.7 0.9 1.7 -11.4 -2.9 5.1
1998 -2.9 7.3 10.1 8.4 2.7 -1.9 2.2 -6.5 -4.9 5.6 7.1 -2.0 4.4
1999 4.4 3.2 7.3 3.4 3.0 2.8 3.6 -3.5 5.4 3.4 16.9 -0.3 4.4
2000 8.3 6.0 11.1 5.8 2.2 9.7 5.4 2.4 9.0 8.5 17.6 5.9 3.9
2001 6.2 9.7 9.8 4.1 4.4 13.2 5.3 5.9 5.0 10.0 20.5 9.1 4.5
Avg: -2.9 -0.9 -4.1 0.1 -6.7 -1.6 -1.5 -6.1 -2.6 97.8 96.1 -5.1 2.7
stddev: 7.22 14.03 12.85 7.95 16.73 7.69 9.85 12.37 6.96 376.25 341.91 9.03 9.86
Source: Economic Survey of Europe (UNECE 2002)
Local Currencies: Theories and Evidence
14
GROWTH RATES FOR THE U. S., BY REGION, AND ARMENIA, 1989 - 2000
State US Mideast New
England
Great
Lakes
Plains Southeast Southwest Rocky
Mntns.
Far
West
Armenia
1989 6.3 5.1 5.2 5.7 6.5 6.3 5.9 5.8 8.7 8.5
1990 5.5 4.7 1.8 4.2 4.7 5.0 7.7 7.4 8.0 -5.5
1991 3.3 2.3 1.3 3.0 4.4 4.6 4.4 5.8 2.5 -11.7
1992 5.3 5.4 3.8 6.6 6.2 6.0 5.8 7.0 3.1 -41.7
1993 4.9 3.9 4.5 5.6 3.2 6.0 7.0 8.5 3.1 -8.8
1994 6.4 4.6 5.7 8.3 8.4 7.4 7.3 8.1 4.3 5.4
1995 5.5 4.6 5.5 4.6 5.3 6.3 6.3 7.5 5.3 6.9
1996 5.6 4.9 5.6 4.4 6.7 5.3 7.5 7.3 5.9 5.8
1997 6.6 5.1 7.2 5.9 6.1 6.4 9.3 8.0 7.3 3.4
1998 6.4 6.6 6.9 6.0 5.0 6.3 5.5 6.9 7.3 7.3
1999 6.1 4.8 6.8 4.5 4.3 6.2 6.6 7.8 8.4 3.2
2000 7.1 6.9 8.3 4.9 6.0 6.6 8.3 9.6 8.9 6.0
avg: 5.7 4.9 5.2 5.3 5.6 6.0 6.8 7.5 6.1 -1.8
stdev: 1.00 1.16 2.12 1.36 1.36 0.75 1.33 1.06 2.37 14.28
Source: Bureau of Economic Analysis 2002 and Economic Survey of Europe (UNECE 2002)
14
GROWTH RATES FOR THE U. S., BY REGION, AND ARMENIA, 1989 - 2000
State US Mideast New
England
Great
Lakes
Plains Southeast Southwest Rocky
Mntns.
Far
West
Armenia
1989 6.3 5.1 5.2 5.7 6.5 6.3 5.9 5.8 8.7 8.5
1990 5.5 4.7 1.8 4.2 4.7 5.0 7.7 7.4 8.0 -5.5
1991 3.3 2.3 1.3 3.0 4.4 4.6 4.4 5.8 2.5 -11.7
1992 5.3 5.4 3.8 6.6 6.2 6.0 5.8 7.0 3.1 -41.7
1993 4.9 3.9 4.5 5.6 3.2 6.0 7.0 8.5 3.1 -8.8
1994 6.4 4.6 5.7 8.3 8.4 7.4 7.3 8.1 4.3 5.4
1995 5.5 4.6 5.5 4.6 5.3 6.3 6.3 7.5 5.3 6.9
1996 5.6 4.9 5.6 4.4 6.7 5.3 7.5 7.3 5.9 5.8
1997 6.6 5.1 7.2 5.9 6.1 6.4 9.3 8.0 7.3 3.4
1998 6.4 6.6 6.9 6.0 5.0 6.3 5.5 6.9 7.3 7.3
1999 6.1 4.8 6.8 4.5 4.3 6.2 6.6 7.8 8.4 3.2
2000 7.1 6.9 8.3 4.9 6.0 6.6 8.3 9.6 8.9 6.0
avg: 5.7 4.9 5.2 5.3 5.6 6.0 6.8 7.5 6.1 -1.8
stdev: 1.00 1.16 2.12 1.36 1.36 0.75 1.33 1.06 2.37 14.28
Source: Bureau of Economic Analysis 2002 and Economic Survey of Europe (UNECE 2002)
Local Currencies: Theories and Evidence
15
REGRESSION TO EXPLAIN RELATIVE DEVIATION FROM THE CIS
Regression Data
Y X1 X2
reldev Agricultur
e
cauc
Armenia 0.94 41 1
Azerbaijan 0.78 19 1
Belarus 0.10 14 0
Georgia 1.32 32 1
Kazakstan 0.07 10 0
Kyrgyzsta
n
0.36 46 0
Moldova 0.71 31 0
Russia -0.04 9 0
Ukraine 0.25 12 0
Uzbekistan 0.37 28 0
Regresssion Results with Constant
Regression Statistics
Multiple R 0.901691
R Square 0.813046
Adjusted R Square 0.759631
Standard Error 0.214356
Observations 10
ANOVA
df SS MS F Significance
F
Regression 2 1.398782 0.69939
1
15.2212 0.002825
Residual 7 0.321639 0.04594
8
Total 9 1.720421
Coefficients Standard
Error
t Stat P-value
Intercept -0.00026 0.146637 -0.00179 0.99862
5
Agriculture 0.012156 0.005704 2.13118
9
0.07054
6
cauc 0.640504 0.157024 4.07900
9
0.00469
6
15
REGRESSION TO EXPLAIN RELATIVE DEVIATION FROM THE CIS
Regression Data
Y X1 X2
reldev Agricultur
e
cauc
Armenia 0.94 41 1
Azerbaijan 0.78 19 1
Belarus 0.10 14 0
Georgia 1.32 32 1
Kazakstan 0.07 10 0
Kyrgyzsta
n
0.36 46 0
Moldova 0.71 31 0
Russia -0.04 9 0
Ukraine 0.25 12 0
Uzbekistan 0.37 28 0
Regresssion Results with Constant
Regression Statistics
Multiple R 0.901691
R Square 0.813046
Adjusted R Square 0.759631
Standard Error 0.214356
Observations 10
ANOVA
df SS MS F Significance
F
Regression 2 1.398782 0.69939
1
15.2212 0.002825
Residual 7 0.321639 0.04594
8
Total 9 1.720421
Coefficients Standard
Error
t Stat P-value
Intercept -0.00026 0.146637 -0.00179 0.99862
5
Agriculture 0.012156 0.005704 2.13118
9
0.07054
6
cauc 0.640504 0.157024 4.07900
9
0.00469
6
Local Currencies: Theories and Evidence
16
Regression Results without Constant
Regression Statistics
Multiple R 0.901691
R Square 0.813046
Adjusted R
Square
0.664677
Standard Error 0.200512
Observations 10
ANOVA
df SS MS F Significance
F
Regression 2 1.398782 0.69939
1
17.3956
4
0.001923
Residual 8 0.32164 0.04020
5
Total 10 1.720421
Coefficients Standard
Error
t Stat P-value
Intercept 0 #N/A #N/A #N/A
Agriculture 0.012147 0.002948 4.12071
6
0.00334
1
cauc 0.640502 0.146881 4.36069
6
0.00241
AUTHOR AFFILIATION
Doctoral Candidate at the University of Barcelona, Spain
16
Regression Results without Constant
Regression Statistics
Multiple R 0.901691
R Square 0.813046
Adjusted R
Square
0.664677
Standard Error 0.200512
Observations 10
ANOVA
df SS MS F Significance
F
Regression 2 1.398782 0.69939
1
17.3956
4
0.001923
Residual 8 0.32164 0.04020
5
Total 10 1.720421
Coefficients Standard
Error
t Stat P-value
Intercept 0 #N/A #N/A #N/A
Agriculture 0.012147 0.002948 4.12071
6
0.00334
1
cauc 0.640502 0.146881 4.36069
6
0.00241
AUTHOR AFFILIATION
Doctoral Candidate at the University of Barcelona, Spain
Local Currencies: Theories and Evidence
17
REFERENCES
Alesina, Alberto and Vittorio Grilli. 1992. "The European Central Bank: Reshaping Monetary
Politics in Europe" in Establishing a Central Bank: Issues in Europe and Lessons from the US.
Cambridge: Cambridge University Press.
Bayoumi, Tamim. 1994. A Formal Model of Optimum Currency Areas. London: Centre for
Economic Policy Research.
Bayoumi, Tamim and Barry Eichengreen. 1993. “Shocking Aspects of European Monetary
Integration” in Adjustment and Growth in the European Monetary Union by Francesco Giavazzi and
Francisco Torres (eds.). Cambridge: Cambridge University Press.
Bertola, Giuseppe. 1993. “Models of Economic Integration and Localized Growth” in Adjustment and
Growth in the European Monetary Union by Francesco Giavazzi and Francisco Torres (eds.).
Cambridge: Cambridge University Press.
Blanchard and Katz. 1992. Regional Evolutions. Washington, D. C.: Brookings Institution.
Bureau of Economic Analysis. 2002. Regional Accounts Data. Washington, D. C.: BEA.
Carlino, Gerald and Robert DeFina. 1999. The Differential Regional Effects of Monetary Policy:
Evidence from the U. S. States. Journal of Regional Science, Vol. 39, No. 2, pp. 339-358. Malden
(MA): Blackwell Publishers.
Cour, Jean-Marie. February 1999. The Financing of Urbanization and Local Development. Paris:
OECD Programme de Developpement Municipal/Club du Sahel.
Desilets, Brien. 2002. Bosnia and Herzegovina: Fiscal and Monetary Development and the Role of
the IMF. Barcelona: Universidad de Barcelona [unpublished].
Grewal, Bhajan and Russell Matthews. 1986. “Federalism, Locational Surplus and the Redistributive
Role of Subnational Governments” in Environment and Planning: Government and Policy, 4.
Ingram, James. November 1959. “State and Regional Payments Mechanisms” in The Quarterly
Journal of Economics. Vol. 73, issue 4 pp. 619-632. Boston: MIT Press.
IMF. April 2003. Republic of Armenia: Third Review Under the Poverty Reduction and Growth
Facility and Request for Waiver of Performance Criterion – Staff Report; and Press Release on the
Executive Board Discussion. Washington, D. C.: IMF.
Kenen, Peter B. "The Theory of Optimum Currency Areas: An Eclectic View," in Monetary
Problems of the International Economy. By Robert Mundell and A. K. Swaboda (eds.). 1969.
Chicago: University of Chicago Press.
Krugman, Paul. 1993. “Lessons of Massachusetts for EMU” in Adjustment and Growth in the
European Monetary Union by Francesco Giavazzi and Francisco Torres (eds.). Cambridge:
Cambridge University Press.
Lucas, Robert E., Jr. July 1988. “On the Mechanics of Economic Development” in Journal of
Monetary Economics. Vol. 22 pp. 3-42.
Mankiw, N. Gregory, David Romer and David Weil. May 1992. “A Contribution to the Empirics of
Economic Growth” in The Quarterly Journal of Economics, vol. 107 Issue 2 pp. 407-437.
17
REFERENCES
Alesina, Alberto and Vittorio Grilli. 1992. "The European Central Bank: Reshaping Monetary
Politics in Europe" in Establishing a Central Bank: Issues in Europe and Lessons from the US.
Cambridge: Cambridge University Press.
Bayoumi, Tamim. 1994. A Formal Model of Optimum Currency Areas. London: Centre for
Economic Policy Research.
Bayoumi, Tamim and Barry Eichengreen. 1993. “Shocking Aspects of European Monetary
Integration” in Adjustment and Growth in the European Monetary Union by Francesco Giavazzi and
Francisco Torres (eds.). Cambridge: Cambridge University Press.
Bertola, Giuseppe. 1993. “Models of Economic Integration and Localized Growth” in Adjustment and
Growth in the European Monetary Union by Francesco Giavazzi and Francisco Torres (eds.).
Cambridge: Cambridge University Press.
Blanchard and Katz. 1992. Regional Evolutions. Washington, D. C.: Brookings Institution.
Bureau of Economic Analysis. 2002. Regional Accounts Data. Washington, D. C.: BEA.
Carlino, Gerald and Robert DeFina. 1999. The Differential Regional Effects of Monetary Policy:
Evidence from the U. S. States. Journal of Regional Science, Vol. 39, No. 2, pp. 339-358. Malden
(MA): Blackwell Publishers.
Cour, Jean-Marie. February 1999. The Financing of Urbanization and Local Development. Paris:
OECD Programme de Developpement Municipal/Club du Sahel.
Desilets, Brien. 2002. Bosnia and Herzegovina: Fiscal and Monetary Development and the Role of
the IMF. Barcelona: Universidad de Barcelona [unpublished].
Grewal, Bhajan and Russell Matthews. 1986. “Federalism, Locational Surplus and the Redistributive
Role of Subnational Governments” in Environment and Planning: Government and Policy, 4.
Ingram, James. November 1959. “State and Regional Payments Mechanisms” in The Quarterly
Journal of Economics. Vol. 73, issue 4 pp. 619-632. Boston: MIT Press.
IMF. April 2003. Republic of Armenia: Third Review Under the Poverty Reduction and Growth
Facility and Request for Waiver of Performance Criterion – Staff Report; and Press Release on the
Executive Board Discussion. Washington, D. C.: IMF.
Kenen, Peter B. "The Theory of Optimum Currency Areas: An Eclectic View," in Monetary
Problems of the International Economy. By Robert Mundell and A. K. Swaboda (eds.). 1969.
Chicago: University of Chicago Press.
Krugman, Paul. 1993. “Lessons of Massachusetts for EMU” in Adjustment and Growth in the
European Monetary Union by Francesco Giavazzi and Francisco Torres (eds.). Cambridge:
Cambridge University Press.
Lucas, Robert E., Jr. July 1988. “On the Mechanics of Economic Development” in Journal of
Monetary Economics. Vol. 22 pp. 3-42.
Mankiw, N. Gregory, David Romer and David Weil. May 1992. “A Contribution to the Empirics of
Economic Growth” in The Quarterly Journal of Economics, vol. 107 Issue 2 pp. 407-437.
Local Currencies: Theories and Evidence
18
McKinnon, Ronald I. "Optimum Currency Areas," American Economic Review. 1963. Vol. 53, pp.
717-25.
Mundell, Robert. "A Theory of Optimum Currency Areas," American Economic Review. 1961. Vol.
51, pp. 657-65.
Mundell, Robert. May 1960. “The Monetary Dynamics of International Adjustment under Fixed and
Flexible Exchange Rates” in Quarterly Journal of Economics. 74, pp. 227-257.
Oates, W. E. 1977. Federalismo Fiscal. Madrid: Instituto de Estudios de Administracion Local
[translated by Pablo Perez Jimenez from the original 1972 publication Fiscal Federalism by Harcourt
Brace Jovañovich, New York].
Pauly, Mark. 1973. “Income Redistribution: A Local Public Good” in Journal of Public Economics,
2(1).
Poghosyan, Tigran. 2003. Demand for Money in Armenia: Partial Adjustment Approach. Prepared
for the Armenia: Recent Economic Trends and Growth Prospects Conference. Washington, D. C.:
Armenia International Policy Research Group.
Romer, Paul M. Winter 1994. “The Origins of Endogenous Growth” in The Journal of Economic
Perspectives. Vol. 8 Issue 12 pp. 3-22.
Romer, Paul M. 1987. “Crazy Explanations for the Productivity Slowdown” in NBER
Macroeconomics Annual by S. Fischer (ed.), pp. 163-202. Cambridge: MIT Press.
Sachs, Jeffrey and Xavier Sala-I-Martin. 1992. "Fiscal Federalism and Optimum Currency Areas:
Evidence for Europe from the United States" in Establishing a Central Bank: Issues in Europe and
Lessons from the US. Cambridge: Cambridge University Press.
Schmitt-Grohé, Stephanie and Martín Uribe. 31 May 2000. Stabilization Policy and the Costs of
Dollarization. Social Science Research Network Electronic Library [Unpublished, available online].
Solomon, Lewis. 1996. Rethinking Our Centralized Monetary System: The Case for a System of
Local Currencies. Westport, Conn. : Praeger.
Standard and Poor´s. 28 February 2002. Acuerdos Provinciales en Argentina: ¿Por qué son tan
difíciles de alcanzar?
Tavlas, George. 1993a "The 'New' Theory of Optimum Currency Areas". The World Economy. Vol.
16, pp. 663-85.
Tavlas, George. 1993b "The Theory of Monetary Integration". Unpublished manuscript. Washington,
D. C.: International Monetary Fund.
Tresch, Richard. 1981. Public Finance: A Normative Theory. Georgetown, Ontario: Irwin-Dorsey L.
United Nations Economic Commission for Europe (UNECE). 2002. Economic Survey of Europe. No.
2. Geneva: UNECE.
18
McKinnon, Ronald I. "Optimum Currency Areas," American Economic Review. 1963. Vol. 53, pp.
717-25.
Mundell, Robert. "A Theory of Optimum Currency Areas," American Economic Review. 1961. Vol.
51, pp. 657-65.
Mundell, Robert. May 1960. “The Monetary Dynamics of International Adjustment under Fixed and
Flexible Exchange Rates” in Quarterly Journal of Economics. 74, pp. 227-257.
Oates, W. E. 1977. Federalismo Fiscal. Madrid: Instituto de Estudios de Administracion Local
[translated by Pablo Perez Jimenez from the original 1972 publication Fiscal Federalism by Harcourt
Brace Jovañovich, New York].
Pauly, Mark. 1973. “Income Redistribution: A Local Public Good” in Journal of Public Economics,
2(1).
Poghosyan, Tigran. 2003. Demand for Money in Armenia: Partial Adjustment Approach. Prepared
for the Armenia: Recent Economic Trends and Growth Prospects Conference. Washington, D. C.:
Armenia International Policy Research Group.
Romer, Paul M. Winter 1994. “The Origins of Endogenous Growth” in The Journal of Economic
Perspectives. Vol. 8 Issue 12 pp. 3-22.
Romer, Paul M. 1987. “Crazy Explanations for the Productivity Slowdown” in NBER
Macroeconomics Annual by S. Fischer (ed.), pp. 163-202. Cambridge: MIT Press.
Sachs, Jeffrey and Xavier Sala-I-Martin. 1992. "Fiscal Federalism and Optimum Currency Areas:
Evidence for Europe from the United States" in Establishing a Central Bank: Issues in Europe and
Lessons from the US. Cambridge: Cambridge University Press.
Schmitt-Grohé, Stephanie and Martín Uribe. 31 May 2000. Stabilization Policy and the Costs of
Dollarization. Social Science Research Network Electronic Library [Unpublished, available online].
Solomon, Lewis. 1996. Rethinking Our Centralized Monetary System: The Case for a System of
Local Currencies. Westport, Conn. : Praeger.
Standard and Poor´s. 28 February 2002. Acuerdos Provinciales en Argentina: ¿Por qué son tan
difíciles de alcanzar?
Tavlas, George. 1993a "The 'New' Theory of Optimum Currency Areas". The World Economy. Vol.
16, pp. 663-85.
Tavlas, George. 1993b "The Theory of Monetary Integration". Unpublished manuscript. Washington,
D. C.: International Monetary Fund.
Tresch, Richard. 1981. Public Finance: A Normative Theory. Georgetown, Ontario: Irwin-Dorsey L.
United Nations Economic Commission for Europe (UNECE). 2002. Economic Survey of Europe. No.
2. Geneva: UNECE.
Local Currencies: Theories and Evidence
19
TABLES
Table I
Costs and Benefits of Local Currencies
Costs Benefits
Increased transaction costs
Exchange rate uncertainty
Avoid price level adjustments
Satisfy local preferences
Support local economic activity
Seignorage
Table II
U. S. Commercial Banks: Ratio of Generalized
Claims to Total Loans and Investments, 1914 - 1958
Date Government
Securities
Total
Securities
(Percentage) (Percentage)
30 June 1914 4.9 21.9
30 June 1919 16.2 29.6
30 June 1925 11.2 28.3
30 June 1930 10.2 29.4
30 June 1935 36.8 56.9
30 June 1940 40.2 57.7
30 June 1950 54.0 63.2
30 June 1958 35.6 46.7
Source: Banking and Monetary Statistics, 1943, Federal
Reserve Board of Governors, p. 19; Federal Reserve
Bulletin, various [reproduced from Ingram November
1959].
Table III
Economic Distance from CIS, in Terms of GDP Growth
Rates, 1989 - 2001
Relative Deviation
[(i/CIS) – 1]
Correlation
with CIS
CIS 0.00 1.00
Russia -0.04 0.99
Kazakstan 0.07 0.87
Belarus 0.10 0.80
Ukraine 0.25 0.89
Kyrgyzstan 0.36 0.85
Uzbekistan 0.37 0.58
Moldova 0.71 0.80
Azerbaijan 0.78 0.83
Armenia 0.94 0.59
Georgia 1.32 0.69
Turkmenistan 46.34 0.23
Tajikistan 51.09 0.23
Source: Author’s calculations based on data from
Economic Survey of Europe (UNECE 2002)
19
TABLES
Table I
Costs and Benefits of Local Currencies
Costs Benefits
Increased transaction costs
Exchange rate uncertainty
Avoid price level adjustments
Satisfy local preferences
Support local economic activity
Seignorage
Table II
U. S. Commercial Banks: Ratio of Generalized
Claims to Total Loans and Investments, 1914 - 1958
Date Government
Securities
Total
Securities
(Percentage) (Percentage)
30 June 1914 4.9 21.9
30 June 1919 16.2 29.6
30 June 1925 11.2 28.3
30 June 1930 10.2 29.4
30 June 1935 36.8 56.9
30 June 1940 40.2 57.7
30 June 1950 54.0 63.2
30 June 1958 35.6 46.7
Source: Banking and Monetary Statistics, 1943, Federal
Reserve Board of Governors, p. 19; Federal Reserve
Bulletin, various [reproduced from Ingram November
1959].
Table III
Economic Distance from CIS, in Terms of GDP Growth
Rates, 1989 - 2001
Relative Deviation
[(i/CIS) – 1]
Correlation
with CIS
CIS 0.00 1.00
Russia -0.04 0.99
Kazakstan 0.07 0.87
Belarus 0.10 0.80
Ukraine 0.25 0.89
Kyrgyzstan 0.36 0.85
Uzbekistan 0.37 0.58
Moldova 0.71 0.80
Azerbaijan 0.78 0.83
Armenia 0.94 0.59
Georgia 1.32 0.69
Turkmenistan 46.34 0.23
Tajikistan 51.09 0.23
Source: Author’s calculations based on data from
Economic Survey of Europe (UNECE 2002)
Local Currencies: Theories and Evidence
20
Table IV
Economic Distance from the U. S., 1989 – 2000
Region Relative Deviation
[(i/US) – 1]
Correlation
US 0.00 1.00
Southeast -0.25 0.75
Rocky Mountains 0.06 0.53
Mideast 0.17 0.85
Southwest 0.34 0.62
Plains 0.37 0.49
Great Lakes 0.37 0.53
New England 1.12 0.84
Far West 1.38 0.73
Source: Author’s calculations based on Bureau of
Economic Analysis 2002
Table V
Economic Distance from the U. S., 1989 – 2000
Region Relative Deviation
[(i/US) – 1]
Correlation
US 0.00 1.00
Southeast -0.25 0.75
Rocky Mountains 0.06 0.53
Mideast 0.17 0.85
Southwest 0.34 0.62
Plains 0.37 0.49
Great Lakes 0.37 0.53
New England 1.12 0.84
Far West 1.38 0.73
Armenia 13.33 0.49
Source: Author’s calculations based on Bureau of
Economic Analysis 2002 and Economic Survey of Europe
(UNECE 2002)
20
Table IV
Economic Distance from the U. S., 1989 – 2000
Region Relative Deviation
[(i/US) – 1]
Correlation
US 0.00 1.00
Southeast -0.25 0.75
Rocky Mountains 0.06 0.53
Mideast 0.17 0.85
Southwest 0.34 0.62
Plains 0.37 0.49
Great Lakes 0.37 0.53
New England 1.12 0.84
Far West 1.38 0.73
Source: Author’s calculations based on Bureau of
Economic Analysis 2002
Table V
Economic Distance from the U. S., 1989 – 2000
Region Relative Deviation
[(i/US) – 1]
Correlation
US 0.00 1.00
Southeast -0.25 0.75
Rocky Mountains 0.06 0.53
Mideast 0.17 0.85
Southwest 0.34 0.62
Plains 0.37 0.49
Great Lakes 0.37 0.53
New England 1.12 0.84
Far West 1.38 0.73
Armenia 13.33 0.49
Source: Author’s calculations based on Bureau of
Economic Analysis 2002 and Economic Survey of Europe
(UNECE 2002)
Categories
TechnologyDownload
Download Slideshow Get the original presentation fileQuick Actions
Statistics
- Views 0
- Slides 20
- Age 65 days
Related Slideshows
11
8-top-ai-courses-for-customer-support-representatives-in-2025.pptx
JeroenErne2
44 views
10
7-essential-ai-courses-for-call-center-supervisors-in-2025.pptx
JeroenErne2
45 views
13
25-essential-ai-courses-for-user-support-specialists-in-2025.pptx
JeroenErne2
36 views
11
8-essential-ai-courses-for-insurance-customer-service-representatives-in-2025.pptx
JeroenErne2
33 views
21
Know for Certain
DaveSinNM
19 views
17
PPT OPD LES 3ertt4t4tqqqe23e3e3rq2qq232.pptx
novasedanayoga46
23 views